A cause clause that requires a final unappealable judgment is not a removal right, it is a shield

Take a 63 page operating agreement on a 6.8M mixed use JV, with the capital partner putting in 2.1M of a 2.4M equity check, the operator bringing 300k plus the deal, an 8.5% pref and a 70/30 split. Standard enough on the surface. Two provisions in a document like this deserve a second and third read. First, a Cause definition that reads "fraud, willful misconduct, or gross negligence, in each case as finally determined by a court of competent jurisdiction after all appeals have been exhausted." That language means the removal right requires a final unappealable judgment. Practically that is years and six figures of litigation, by which point the asset is long gone. Gross negligence is often the only performance-adjacent trigger in these clauses, and missing a budget by 40% is not gross negligence, it is just poor execution, so it does not qualify. Second, watch for language that says the property management and construction management agreements with the operator's affiliates survive any removal or withdrawal of the manager, terminable only for their own defaults, with a termination fee equal to twelve months of fees. On a deal with meaningful PM fees and a construction budget in the low seven figures, that fee can run into six figures on its own. Even in the scenario where the capital partner wins a fraud judgment years later, the operator can still be managing the building and getting paid to be removed. A buy-sell tied to fair market value as determined by an appraiser the manager selects is a separate red flag worth its own negotiation. The practical fix is a rewrite of the Cause definition to mechanical triggers, tied to objective performance thresholds rather than a court judgment, and a rewrite of the affiliate contract survival language so those agreements terminate on 30 days notice with no fee upon a removal event. Operators will resist both. When only one concession is available, the affiliate contract fix usually matters more, because a cause right that still leaves the removed operator collecting fees defeats its own purpose.

wendy_park48 CU1BPRO 17

Answer

luis_carrera CS1CPRO 12

Fight for 11.2. Fix the affiliate contracts and 9.3 stops mattering nearly as much. The reason: a removal right you can never exercise costs him nothing to give you and costs you nothing to lose. It is decoration in both directions. The affiliate contracts are cash flowing out of the building every month regardless of performance, and the survival clause converts them into an annuity he keeps even if the partnership blows up. That is the clause that is worth real money to him, which is exactly why he will defend it and exactly why it is the one to take. There is a second reason 11.2 is the better fight. If the management contracts terminate on notice with no fee, you have leverage without litigation. The month he misses reporting or blows the budget, you sit down and say the PM contract goes away unless X happens. You never have to prove gross negligence to anybody. Practical remedies beat theoretical ones. It is also worth pushing a middle version of 9.3 that he can say yes to without feeling accused of anything. Add failure to fund a required contribution after a 10 day cure, and a loan event of default, as separate removal events with no court finding required. Those are objectively verifiable from documents he already has to produce, and most operators will concede them because they read as "if I default I'm out" rather than "if you think I'm bad I'm out." One more, on the buy-sell in 12.4. An appraiser selected unilaterally by the Manager is worse than the survival clause in a bad scenario. Three appraisers, each side picks one, the two pick the third, or you are negotiating your own exit price against his appraiser.

luis_carrera CS1CPRO 12

6 replies

devon_pierce SS4APRO 15

This thread is worth reading twice for anyone learning what to look for in an operating agreement. The final unappealable judgment language belongs on every LP's red flag list. One question. If he wrote 9.3 and 11.2 that way himself, isn't that information about him? Or is that simply what his lawyer's template says, and he has never read page 41?

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devon_pierce SS4APRO 15

tonyv88 PU4APRO 10

@devon_pierce it is usually the template, honestly. Survival clauses exist because a management company that gets fired every time an equity partner gets nervous cannot staff a building, and from the management side that language is standard. That part is not sinister. The twelve month termination fee is a different animal. Standard third party PM contracts run 30 to 90 days notice without cause, no fee, often 60. Twelve months of fees is a number somebody chose. Fathom, ask him what his company's standard third party contract says and then ask why this one is different. That is a hard question to answer badly.

tonyv88 PU4APRO 10

joe_delgado5ActivePRO

78k of PM fees plus a construction management fee he'd keep collecting on a 1.4M budget he's no longer supervising. That's the whole thing right there. Take 11.2 and let him keep his fancy removal clause.

joe_delgado5ActivePRO

aaron_fitz10 PU1APRO 13

This is a useful thread for anyone working through the same question. @luis_carrera's point about verifiable triggers is the piece most people miss. Failure to fund and loan default are facts rather than judgments, and an operator can agree to them without conceding he is the kind of person who would need removing. Fathom, when you send it back, are you sending both rewrites at once or leading with 11.2? I would send both. If you lead with the one you actually want he will trade you the other one and think he won.

aaron_fitz10 PU1APRO 13

dmitri_248 CB2CPRO 11

Two things to check while you are in there, since you are already at 2.1M of a 2.4M check. Whether a for cause removal touches his unvested promote at all. If he keeps the full 30 percent after removal, you have hired a permanent passive partner in your upside. Some drafts reduce it to a percentage based on time elapsed, some extinguish it entirely for cause, and the difference is enormous at exit. Also check whether the loan documents name him as the required key principal or guarantor. If the lender's approval is needed to replace the Manager, your removal right in 9.3 is subject to a consent you do not control, no matter how you rewrite the trigger. A clean removal provision gets made useless by a two line clause in the loan agreement more often than people expect. Whether the lender will pre approve a substitute is worth asking now, in writing, and how any of this actually plays out depends on the governing state's LLC act, so let your counsel read the two documents side by side.

dmitri_248 CB2CPRO 11

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